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Executive Summary

Allergan is the diamond in the rough for SmithKline shareholders in the merger plan with Beecham. The ophthalmic/otic/dermatological business is being spun off to SmithKline shareholders as a way of sustaining Wall Street support for the merger. As part of SmithKline since 1980, the fast-growing Allergan has never been fairly valued. As an independent company, the stock market will be able to polish the price of the company to reflect its historic 30% annual growth and its potential value as a takeover candidate. With 6,580 employees and 1988 annual sales of $ 755.8 mil., Allergan's closest rival as a freestanding U.S. ophthalmics business is Bausch & Lomb, which had 1988 sales of $ 978.3 mil. Widely viewed as undervalued in 1988, Bausch & Lomb has been the subject of recurring acquisition speculation. Organized into six segments, Allergan develops, manufactures and markets prescription and non-prescription ophthalmic products for the treatment of eye diseases and disorders; daily and extended wear contact lenses and contact lens products; intraocular lenses; microprocessor-based ophthalmic diagnostic instruments; and a line of skin care therapeutic products. Allergan reported operating income of $ 137 mil. in 1988, up 36% from 1987. Sales also grew by 36% to $ 756 mil. The company spent $ 64.5 mil. on R&D last year, or approximately 8.5% of sales. According to the current agenda for the merger, the spinoff of Allergan probably will not occur until late summer. The merger plan for the creation of SmithKline Beecham calls for a distribution of .5 shares of Allergan to each SmithKline Beckman shareholder. The Allergan distribution is the hidden value in the deal; the shares are a good bet for a price run-up due to either takeover talk or a leveraged buyout. Gavin Herbert, the CEO of Allergan prior to its acquisition and currently SmithKline Beckman exec VP, is expected to go with Allergan in the spin-off. He would have the financial clout to put take Allergan private again in a leveraged buyout. SmithKline is not yet revealing what valuation will be set on Allergan. Details of the proposed 50/50 merger will be outlined in documents filed with the Securities and Exchange Commission in May. At that time, registration statements will be filed covering the divestiture of Allergan and the remaining 84% of Beckman instruments. SmithKline Beckman shareholders will receive a special $ 5.50 a share cash dividend, along with .18 share of Beckman and .5 shares of Allergan. In the September sale of 16% of Beckman, SmithKline priced the diagnostic instrumentation business at $ 19 a share, or approximately seven times Beckman's 1988 operating income of $ 83 mil. If that same ratio were applied to Allergan, the ophthalmics business would carry a valuation of nearly $ 1 bil. However, SmithKline may well assign Allergan the higher ratios typically associated with drug firms: most pharmaceutical stocks are priced 15 to 20 times net earnings, which would put Allergan's market value substantially higher. A valuation of 20 times expected net earnings, a P/E ratio conservatively consistent with the company's growth, would give the company a valuation between $ 1.5 bil. and $ 2 bil.